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A Rare Do-Over For Equity Investors?

Tyler Durden's picture




 

Submitted by Jay Leopold via Columbia Threadneedle Investments,

  • While the market may still rally to new highs, the late August free fall in stock prices and spike in volatility served as a wake-up call for investors. 
  • In the past ten weeks, major equity indices have recovered virtually all the losses experienced during the August swoon.
  • The recent rally gives investors a second opportunity to position their portfolio for an important inflection point in monetary policy as the Fed likely starts raising interest rates.

The Merriam-Webster definition of do-over is “a new attempt or opportunity to do something after a previous attempt has been unsuccessful or unsatisfactory.” How many times in life have you longed to revisit an unfortunate or unwise decision, essentially wishing for a do-over? Maybe it was that email you sent? That spicy meal you ate? With a little thought, each of us could compile a long list. This is especially true in the highly competitive and constantly evolving world of investing.

The spring and summer months were cruel to many areas of the capital markets, as commodities, the dollar, credit spreads and emerging markets began to discount the beginning of a tightening cycle by the Federal Reserve. U.S. equities were a notable exception as of mid-August, as equity valuation levels and major indices remained near all-time highs.

But in a seeming blink of an eye, equities joined the wave of de-risking that gripped many markets, with the S&P 500 tumbling a stunning 11% in the space of several days in late August. While some portfolios were reasonably well-positioned and outperformed their benchmarks, this downdraft was wholly unsatisfactory to many investors.

In the past ten weeks, major equity indices have recovered virtually all the losses experienced during that dizzying plunge. Risk appetites have generally returned to pre-swoon levels, as seen in Exhibits 1 and 2 depicting valuation levels and the volatility index (VIX). While bond markets have recovered a bit since late August, fixed income investors remain generally skeptical, with spreads wider (risk-averse) than last spring (Exhibit 3 and 4).

S&P 500 Forward P/E, Volatility Index

Investment Grade vs 5-yr Treasury Spread, High Yield vs 5-yr Treasury Spread

Events have unfolded to give equity investors a rare do-over: a new opportunity to re-visit a past decision regarding portfolio risk. We are not suggesting the market will plunge, but that the recent rally provides a second opportunity to position your portfolio for an important inflection point in monetary policy as the Fed likely starts raising interest rates for the first time since 2007.

The future is always uncertain, and a bull and bear case for stocks can be made.

Some bulls argue that the widening of spreads is discounting several impending hikes and that spreads will come back down after the Fed acts. While possible, this theory depends on several “ifs” that may or may not occur.  Second, bulls posit that the initial hikes of a tightening cycle won’t do enough to harm the economy and actually signal solid expected economic growth. A reasonably steep yield curve currently supports this argument.

 

The bear case remains roughly the same as it was in mid-August: equity valuation levels are high in absolute terms and appear somewhat out of step with the recent deterioration in fixed income, commodity and emerging markets, where investors remain relatively cautious. This suggests further multiple expansion will be more difficult from here. In addition, the economic expansion is seven years old, and may be much closer to the end than its beginning. Finally, the unwinding of the unprecedented easy monetary policy could have some unforeseen consequences.

Investors need to take risks to achieve their objectives. The key is to get adequately compensated for those risks. While the market may still rally to new highs, the late August free fall in stock prices and spike in volatility served as a wake-up call.

Investors who were not properly positioned and frustrated by their performance in the late August swoon are being given a do-over to reposition their portfolios in a manner that creates the proper balance relative to their long-term return goals and risk tolerance.

 

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Tue, 11/10/2015 - 12:22 | 6772486 KnuckleDragger-X
KnuckleDragger-X's picture

The only sane position is to get far, far away from Wall St., too bad the sheep will do the opposite......

Tue, 11/10/2015 - 12:29 | 6772492 Hitlery_4_Dictator
Hitlery_4_Dictator's picture

Bears make money, bulls make money, pigs get slaughtered - American's are pigs. They will ride the wave and do nothing. Pathetic. Like Pink Floyd said "Are there any paranoids in the audience tonight? Is there anybody who worries about things? Pathetic. This is for all the weak people in the audience. Is there anyone here who's weak? This is for you. It's call 'Run Like Hell'. Let's all have a clap! Come on, I can't hear you! Put your hands together! Have a good time! Enjoy yourselves! That's better!"

Tue, 11/10/2015 - 12:24 | 6772490 Dr. Engali
Dr. Engali's picture

Soooo, BTFD? Buy gold? Buy silver? Buy oil? Land? Invest with the nice prince from Africa who keeps emailing me? Tell me wtf to do damn it!

Tue, 11/10/2015 - 12:27 | 6772510 SSRI Junkie
SSRI Junkie's picture

when in doubt, do nothing (my motto for 7 years now)

Tue, 11/10/2015 - 19:19 | 6774658 maxamus
maxamus's picture

Had you bought 7 years ago you would have made a fortune.

Tue, 11/10/2015 - 12:29 | 6772522 NoDebt
NoDebt's picture

Stay the hell outta the markets until QE4 is announced.  (Or better yet, RUMORED to be announced.)

Tue, 11/10/2015 - 12:33 | 6772546 MadVladtheconquerer
MadVladtheconquerer's picture

The best position to be in:  bent over backing up and barking.

WOOF!  WOOF!

Tue, 11/10/2015 - 13:32 | 6772933 ceilidh_trail
ceilidh_trail's picture

Not if obama is behind you...

Tue, 11/10/2015 - 12:36 | 6772568 lordbyroniv
lordbyroniv's picture

i am buying numeric domain names !!!!  chinese love that shit. fuck stocks.

Tue, 11/10/2015 - 12:38 | 6772575 Sudden Debt
Sudden Debt's picture

The bank will probably give you that 6th morgage on your house so you can short this market yet again...

why not...

if the banks say it's a good bet... they can't be wrong 20 times in a row even as most of them hardly have a negative trading day with their own accounts...

and maybe this totally rigged market will suddenly become unrigged for a moment... just because...

 

 

Tue, 11/10/2015 - 12:50 | 6772662 Grandad Grumps
Grandad Grumps's picture

The world would be better off without equity markets. There would be much less corruption and misallocation of assets.

Tue, 11/10/2015 - 13:16 | 6772835 I Write Code
I Write Code's picture

The market is fluctuating!  Alert the media.

Tue, 11/10/2015 - 13:16 | 6772837 MD
MD's picture

The Fed is not raising rates in December.  The stock market and housing markets must be propped up.  "Wealth effect" and all.

Tue, 11/10/2015 - 13:34 | 6772946 ceilidh_trail
ceilidh_trail's picture

Good shot that they will. They have other ways of easing, such as rolling over more treasuries.

Tue, 11/10/2015 - 14:14 | 6773192 scubapro
scubapro's picture

 

retail is not seeing this as a selling or risk-reduction oppty.   they see this as confirmation that btfd and btfath will always work.   the hook is deeply set and retial wont panic until were 15% lower than now, then sell lower to give the big boys a nice 20% discount where to come back in.

Tue, 11/10/2015 - 14:33 | 6773340 christiangustafson
christiangustafson's picture

2135, then 1737, on the S&P 500, ladies.

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